Limited Brands Earnings: Trends We're Watching

Limited Brands (LTD) is scheduled to release its Q4 fiscal 2012 earnings on Feb. 27. According to the retailer's January sales results, the company shows comparable-store sales growth of 5% for the fourth quarter. This growth is slightly less than what the retailer has seen previously, and we believe that the weak holiday season in the U.S. is the reason for it. Nevertheless, the launch of new product categories and strong brand recognition have helped the retailer achieve steady growth in Q4 as well as for the full fiscal year. Limited Brands has been consolidating its store network in the U.S. to improve store productivity, and this trend is likely to continue in the fourth quarter as well. In addition, we expect strong growth in Limited Brands' direct-to-consumer channel.

Strong Brand Recognition and New Product Launch Will Help Results

Limited Brands dominates the personal care and intimate-apparel market with itsBath & Body Works and Victoria's Secret brands. Victoria's Secret registered positive comparable sales growth of 6% in Q3 fiscal 2012, driven by promising results from PINKand bras and panties. For the holiday season, the brand adopted celebrity publicity strategy and launched new products such as Angel's Fantasies bras, Angel Gold Fragrance and the Flirt Bra, which helped it register 3% comparable-store sales growth in the fourth quarter. But the growth was relatively slow due to overall weak holiday season in the U.S. However, the figure for the entire fiscal year stood strong at 7%, indicating that the temporary weakness could not offset an otherwise good year for Victoria's Secret.

Bath & Body Works' comparable-store sales improved by 5% in Q3 fiscal 2012. This can be attributed to positive customer response to changes in its signature collection, soap and sanitizer, and home fragrance product assortments. Also, the launch of new fragrance and an exclusive range of holiday collection and gifts led to comparable-store sales growth of 7% in the fourth quarter.

Store Consolidation to Continue

Limited Brands has been closing its underperforming Bath & Body Worksstores to improve profitability. While the store count has fallen in the last few years, the revenue per square feet has increased. At the same time, revenues rose at a moderate rate of 5% annually. This trend is likely to continue in the fourth quarter and will support the retailer's margins.

Limited Brands is following a similar strategy with Victoria's Secret. The brand's store count fell from 1,040 to 1,017 during 2009-11. Simultaneously, revenue per square feet increased from $581 to $754 with an overall revenue growth of 15% annually. However in Q3 fiscal 2012, the number of stores grew to 1,020 due to expansion of Victoria's Secret's new brand, PINK.

Expect Slightly Better Margins and Strong Growth in Direct-to-Consumer Business

Limited Brands reported a decline of 22% in its net income due to higher expenses and lower sales in the third quarter of fiscal 2012. This decline can be attributed to the absence of tax benefits, one-off costs related to staff training, store development and the addition of Windows and POS to the stores. Moreover, Limited Brands also invested in the opening and remodeling of 40 stores. This led to an increase of about 7% in the store operating expenses in the third quarter. Since these were the preparatory steps for the holiday season, we expect these expenses to be lower for the fourth quarter.

On average, Limited brands' direct-to-consumer revenues have grown by about 20% annually over the past couple of years. Moreover, major players in the U.S. apparel industry such as Urban Outfitters (NASDAQ:URBN), American Eagle Outfitters (NYSE:AEO), and Abercrombie & Fitch (NYSE:ANF) have witnessed similar growth. We expect Limited Brands to benefit from this trend in Q4 fiscal 2012 as well. We estimate that direct-to-consumer business accounts for about 25% of the retailer's value.

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